SKY PLC (ADR) (OTCQX:SKYAY) Q4 2016 Results Earnings Conference Call July 28, 2016 10:30 AM ET
Jeremy Darroch - CEO
Andrew Griffith - CFO
James Dix - Wedbush Securities
Scott Wipperman - Goldman Sachs
Allan Nichols - Morningstar
Thank you and welcome to the Sky PLC Results Conference Call for the 12 Months ended 30 of June, 2016. Today's call is being recorded. Hosting the call will be Jeremy Darroch, Chief Executive Officer and Andrew Griffith, Chief Financial Officer. This call is a property of Sky PLC. It may not be recorded for broadcast without the permission of Sky PLC.
This call may include certain forward-looking statements with respect to the Group’s business and strategy. All forward-looking statements are subject to risks and uncertainties and are qualified by the cautionary statements in Sky’s 2015 Annual Report as updated by its 2016 Interim Management Report.
I would now like to hand the call over to Mr. Jeremy Darroch. Please go ahead, sir.
Thanks, good morning, everybody and thanks for joining us today. I'm here as you know with Andrew Griffith, who is our COO. And so hopefully you had a chance to see the full presentation on our website. And so what I'd like to do is begin this morning by taking you through the highlights of our operational and financial performance. And then I'll talk a bit about the plans we have for the year ahead. Andrew and I of course will then be happy to take any questions that you've got.
So this has been another year of really very strong performance from the group. In each of our markets we're winning with customers. In the UK and Ireland, our focus on broad growth took us past £8 billion in revenue. In Germany and Austria, we delivered our first full year of profit whilst making important investments for the future, and in Italy we've returned to growth with more customers responding to the proposition that we were offering in that market.
We're delivering our strategy at both pace and scale, widening our leadership in each market as we focus on entertainment, innovation and service. Our work on operating efficiency has accelerated during the year and it will be a significant source of future value. And finally, we're growing our capabilities and effectiveness. Across the group, demand for customers remain strong. We added over 800,000 new customers during the year, taking our total customer base across Europe to just under $22 million. And we grew our total products by $3.3 million meaning there are in all $57 million products in customers' homes.
You can say I think from our financials that we've had another really strong year. Revenue was up in every market and we added £750 million of revenue this year. Our subscription services rose by 6%, but more importantly our new revenue streams are growing faster than ever, helping to accelerate the overall growth rate of the group to 7%. We've got a strong focus on costs, driving hard on operating efficiency and that's giving us the capacity to invest in the customer proposition. So our SG&A costs have increased by just over 10% in the last six years and we had a big year ahead of efficiency for us as a business, and we expect to realize the equivalent of some £300 million of savings. Each of this means that our operating costs as a percentage of sales continue to fall over time.
Now as a result of that, this gives us the capacity to invest on screen, and today we spent essentially the same proportion of revenue on programming as almost a decade ago. The strong focus on cost has helped us to drive good growth in operating profit of 12% and earnings per share was up by 13%. We're well placed to make good returns for shareholders and today we've announced further growth in the dividend of £33.5 for our 12th successive year.
So that was 2015-2016. You look ahead to 2016-2017; we can see significant opportunity for growth in each of our markets. This year our focus in the UK will be to take full advantage of the investments we've already made in the likes of Sky Q, Now TV and great content like the EPL We’ll deliver strong, broadly-based revenue growth for our existing businesses and we have the entirely new opportunity in mobile and we will launch into this market next year as well.
Moving to Germany and Austria, this is our single largest opportunity. It’s the biggest and most affluent market in Europe where Pay-TV penetration’s just 20%. I think it’s no exaggeration to say that if we get it right the opportunity here is game changing. There’s already strong demand for TV with average viewing at almost four hours a day. We’ve had a productive first 2 years in Germany and Austria and our focus now is to increase the level of Pay-TV penetration in these rich and attractive countries.
To do this we’ve got a clear roadmap for the business. This roadmap is based on what we have implemented elsewhere and know works, but with specific tailoring and execution for the German market. It’s built around four key priorities. Firstly, we’re widening our content proposition to offer Sky for everyone in the household. We know this is important to persuade more households to sign up over time, and it’s been a key part of our journey in the UK. Second, we’re broadening our range of products and services to give customers more choice and flexibility about how they consume their content.
Third, we’ll be step-changing the rate and pace of innovation in the German market. I think Germany and Austria have been crying out for this and it’s one of the things that has worked so well elsewhere, and constantly puts more value back into our subscription offer. And then finally we’re starting early on the path to building entirely new and additional revenue streams. That’s an important way for us to maximize our returns.
And then finally turning to Italy, the business here as performed well, proving to be resilient through the economic downturn and it’s now growing again. We’re implementing our strategy well. We provide the best TV entertainment, we’re broadening our distribution, including building a strong position in free-to-air, and we’re widely seen as the innovation leader with the highest customer satisfaction.
In fact, the Sky brand is probably the strongest leadership position at residents of any of the Sky brands of the markets that we’re in. So I think you can see that we’ve got exciting plans ahead of us for 2016-2017 in each of our markets. Now this morning at London we also talked a lot about efficiency in the programs that we have right across the businesses there. I won’t take you through it all in detail, but I would emphasize that efficiency is really culturally important at Sky. It creates the fuel to invest more in what matters for customers, it’s great content and market-leading innovation, alongside delivering higher profits, and 2016/2017 is going to be our biggest year yet on securing greater efficiency.
In addition, as the enlarged Group we’ve been able to access an additional deep layer of cost efficiency due to the integration of the three Skies. Two years ago we set ourselves a target to achieve GBP 200 million of run rate synergies by next June and we’re well on track to exceed that target. Going forward, we’ll continue to benefit from these synergies as well and this, combined with new additional initiatives, means that we’re now targeting GBP 400 million by the end of 2020. So in summary, we’ve had a great 2015/2016. We’ve got strong plans for 2016/2017 in each of our markets, underpinned by our relentless focus on efficiency and we think the opportunity ahead for this business is significant.
So with that, we’d be very happy to take any questions.
[Operator Instructions] And our first question comes from James Dix with Wedbush Securities. Please go ahead.
I had two. I guess the first might not be particularly surprising, but perhaps an update on any outlooks you're seeing after the Brexit vote in terms of impact on consumer confidence or just your outlook for consumer demand across your three markets. And then secondly, I'm always interested in an update on AdSmart. Now at the close of the fiscal year, how do you see it competing as more video viewing does shift to IT delivery? And then are there any developments on the buy side at the advanced TV market which you see occurring that could affect the performance of AdSmart?
Okay. Sure, James its Jeremy here. I'll go first and I'll pass it over to Andrew. On Brexit, we really haven't seen any effects yet and I think if there are -- the extent to which there are, it's still too early to say. But I would say through all of our markets that the opportunity is really around market growth and growing penetration in each of the markets in which we compete. And so it's not particularly leveraged to the overall economic environment in any of our markets. And indeed if that was to turn down, say in the UK as we obviously saw in 2009, we did well then. We saw, we often see consumers return to the home and other elements of discretionary spend of course is a home-based service, the leading home-based service in all of our markets. I think relatively that puts us in a good position. So we're obviously keeping very close tabs on it and staying flexible, and so far, really no effect for our business.
Hi, James. AdSmart is going well. It continues to build strongly. Its revenues over the last year almost doubled. And we're working with a broad range of partners. So companies like Viacom have come onto the platform in the UK. And I think we're pretty well insulated against shifts of viewing between platform. Importantly you should know that AdSmart enables -- it's the ad serving technology that serves ads into all of the different consumption devices that Sky offers. So customers consuming on Sky Go, which is our tablet and mobile offer received AdSmart ads in just the same way as in linear. So actually we don't see any shift between platforms, and of course all of those platforms are new opportunities for Sky.
In terms of the buy side, I think we're very well placed. There is a big trend in terms of clients looking for transparency and accountability, and AdSmart has transparency designed in from the start. So customers only pay for the impacts that are delivered. All of those impacts are delivered in high quality context environments and they are all measured by an independent third party, and that is auditable. So I think one of our great strengths is that built in transparency, it makes it very resilient against some of the changes that you're seeing on the buy side. And what we would say is that for our clients, AdSmart gives them all of the best targeting of digital, the best data, the best analytics and the ability to segment their audience. But also all of the quality of TV, high quality contextual audiences, a transparent environment and one that's independently audited and verified.
Just one follow up on that. Roughly how much of the revenue is purchased through agencies so far as you can tell as opposed to clients directly, advertise this directly on the platform?
Almost 100% of our revenue involves a client-direct conversation. By definition, clients have to choose the segments, and a lot of that granularity of data, as well as, often in cases where customers actually want to do a detailed data match involves the client. And all of our sales function in AdSmart involves the client as well. So all of it really has a client aspect to it. The size of a campaign on AdSmart often brings in as well new advertisers to TV, people who would otherwise be doing only digital or local press, and not all of those have agencies. They certainly don’t all have agency-share deals in place.
That said, we’re not trying to disintermediate the agency. We work with every agency and every agency has booked clients on AdSmart or has booked some of their clients onto AdSmart. So it tends to be a three-way relationship instead of what is normally for linear TV in the UK, bilateral between a media owner and an agency. Does that answer your question, James?
Moving on, our next question comes from Scott Wipperman with Goldman Sachs.
Thank you for taking my questions and for doing the call. First for Andrew, I think, I recognize I asked this I think on the last call, but just seems relevant in light of the movement in the euro/pound exchange rate. I guess just on the debt structure, just hoping to maybe just discuss are you still comfortable with the hedging you have in place in terms of the amount of euro-denominated debt, given the negative impact we've seen to net leverage from the currency translation?
Okay. I will take that and then you can ask your other question?
Yes, our, that hedging structure is working. Although optically 70% of our debt is denominated in euros, the same is not true of the level of interest, because that euro debt attracts a lower rate of interest, a lower coupon. You’ve got to remember -- one of the things that you should remember is that we have a strong and profitable business in the Republic of Ireland, that uses euros as well. So the euro EBIT that we’ll get this year will exceed the level of euro interest, which means that at an earnings level that hedge is working well. And whilst it’s true that on a spot basis you’ve seen an increase in the level of gross debt due to retranslation, we use internally, and with our bank covenants, we use an average level of net debt-to-EBITDA. On that basis leverage actually fell over the last year and that’s how all of our bank covenants and liquidity is driven. It’s also how we express our target, which we reaffirm of getting down to 2 times net debt-to-EBITDA.
So I don’t want you to think we’re complacent. I mean we manage this in the round and we keep an eye on it as best as we can, on exchange rates, but with a long-dated portfolio, no impending redemptions of debt, we’re comfortable with where things are today. And I’d say that hedging is working and it will actually, as our euro revenues and profits grow, it’ll continue to work.
Got it. That’s helpful. So in terms of tracking the progress towards your deleveraging target, we should be looking at kind of the average number that you put in the release today.
Yes. I think that’s a better measure of underlying process than spot, particularly in volatile environments. And you’ve seen that clearly this year where the Brexit vote was five working days before our year-end.
Yes. And the rating agency discussions along those lines? I mean did they agree with looking at it that way, or your comfort level in terms of kind of how the rating agencies are looking at it?
You never say never, but I'm pretty comfortable with the development of that rating and it's our job to show the -- actually underlying performance of the basis, which is what's generating the cash to cover and service. The interest is performing well and you can see from today's results, the revenues are growing and profits are up.
Yes. Okay. No, that, it's something we've been getting some questions on. So just wanted to just address on the call. So appreciate all those answers. And then, just a last one. Just in Italy, just in light of some of the uncertainty around the Vivendi media set transaction, can you maybe just talk about the competitive environment there, as well as whether or not you would consider your comfort in terms of considering M&A or whether or not you need M&A in the Italian market over a longer term?
Yes. Sure, Scott. Jeremy here. Look, I think that we're very happy with our journey of travel in Italy in the last three quarters. The business is now growing again, was important in terms of a direction of travel. And so we're delighted with that. We think and I think we've got the right asset in Italy. That's not to say that, if anything in that sector is around, you might not take a look at it, but assuming no need for us do anything. So we can approach any opportunity for M&A in Italy from a position I think of strength. And we've got a really strong employment in Italy next year. So we're going to be able to the pace for a list to follow in terms of what we're really doing on screen and content and particularly in our product innovation. So we feel that we've got all the tools at our disposal and you just get on and build that business.
And before we move onto our next question. [Operator Instructions] And our final question in the queue comes from Allan Nichols with Morningstar
Two, actually. First, on Slide 69, it shows several costs that reduce the adjusted operating profit from £1.558 billion down to the statutory results of £977 million. Are these one-time adjustments or will they recur, particularly the amortization of acquired intangibles? And secondly, you announced price increases in the UK of 4% to 5%, which is higher than you've taken the past several years. What provides you with the confidence to implement such a large price increase? Thank you.
Sure. Jeremy here. I will be doing that, Andrew will do the first one and I think first of all in the quarter we've got our pricing through the UK. So that's good from an operational of view. That's behind us. I think it is just the -- almost a breadth of what we're doing. The UK business today had a really good 2015-2016 but we're really developing in relation and real scale of the pace now, we're broadening out considerably the amount of content we offer customers. And I think it is that, that gives us confidence that we can take a little bit more price in the parts we haven't in the past. Now we always assume that should happen year, but if we can keep getting the product better, keep adding more to the service of customers, then I think the overall outlook for pricing is very strong.
Hi Allan. Yes, we present in our slides, just to be helpful we lay our two tables that reconcile statutory numbers to adjusted, and we do that on 68 for 2016 and then 69 for the preceding year. So I’ll just talk about 2016 to start off with if I may. You’ve got a mixture. There are some one-time items. The final residue of transaction costs will not recur. The majority of the acquisition integration costs have already been incurred. Some of those may run into next year. We tend to have an ongoing set of corporate restructuring and efficiency programs.
So in most years I would expect something within that category. Derivatives are non-cash and dependent really on our portfolio of hedges at the year-end. So that’ll always be an item and I can’t predict in which direction that will go. And then there will always be some amortization of intangibles. That part which relates to Italy and Germany is broadly constant at around GBP 340 million and there’ll be a much smaller number that relates to some of the customer base that we’re amortizing over a shorter period of time. So hopefully that helps. It’s a mixture between items that will drop out or decrease as we go forward and some items that will always be reconciling items.
And there are no further questions at this time. I’d now like to turn the conference back over to Jeremy Darroch for any closings remarks. Please go ahead, sir.
Okay. Well look, thank you, everybody, for joining the call today. Just before I finish I did want to mention one thing, which is that we’ll be holding a Capital Markets Day later this year. And obviously, I appreciate it’s a bit further for many of you to come, but we do hope to see you over here if you’re able to make it. So that’s all for us, and I hope you have a really, really good summer and we look forward to talking to you all again soon. Thank you.
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